It’s not everyday that we’re voting on whether to support the buyout of one of our major holdings. While we’ve owned a handful of stocks that have been acquired over the years, the last takeout of a large Monarch holding was Biomet in 2007.
As the proxy forms have just been mailed to EMC shareholders, customers who have chosen to vote their own proxies have started to call us asking our opinion on how they should vote their shares. The short answer is that we’ve elected to vote against the deal, for reasons we’ll delineate below. Obviously, we don’t expect everyone to agree with our reasoning, and the circumstances of some investors should lead them to want the deal to go through more than other investors would.
On October 12, 2015, EMC announced it has agreed to be acquired by Dell Inc., which is owned by Michael Dell and three private equity funds. EMC investors will receive $24.05 per share of cash AND shares of a tracking stock for VMWare (VMW), equivalent to .111 share of VMW for each EMC share owned. The value of the cash component is roughly $47 billion, making this a humongous deal for any acquirer, but a very humongous deal for a privately-held acquirer. [Recall that Michael Dell, and his private equity partners, bought Dell in 2013 at a very favorable price.] Dell would fund most of the $47 billion by issuing new debt.
We are admirers of Michael Dell and the historical success of his company, especially in light of how it has performed since the PC market started shrinking a couple years ago, and compared to the performance of IBM and HP, its publicly-traded peers. We also think the combination of Dell and EMC would create good synergies, as the company would be able to reduce costs, and stand a decent chance of winning more new business from the combination than it will lose.
Reasons for the No Vote
That said, we think EMC shareholders are getting shortchanged by the price offered. We believe the price is simply not attractive enough, given the long-term growth potential of EMC’s business and its massive cash flow. This is not the hyper-growth company it once was, but still, the world is constantly needing to store and transmit more and more data, and do it more productively, more quickly, and more efficiently. Product sales have plateaued, but services (now 40% of sales) revenues continue to grow. We see EMC as a 5%+ earnings growth business over the long-term.
The other issue concerns the VMW tracking stock. VMW is publicly-traded, but EMC owns 65% of the stock. Dell/EMC don’t want to spend the money to buy VMW, but they want to retain operating control of the company. If they just gave all the VMW shares to EMC shareholders, Dell/EMC would have ceded control of VMW. Instead, EMC shareholders will get “tracking stock,” meaning they own a security which mimics ownership of the company, rather than giving actual voting ownership of the company. Meanwhile, current shareholders of VMW will retain their voting-interest shares in the company. So, 2 classes of VMW stock will trade on the market, and the tracking stock will likely trade at a sizable discount to the other shares (much like Google’s 2 classes of stock). That discount will likely be very large at first, as some EMC shareholders will just choose to dump their VMW shares, maybe peaking at 10-15%, but the discount should narrow to 5-10% over time.
Do we want to own VMW tracking stock? The short answer is not really. Its business is changing rapidly, as IT spend moves away from enterprise data centers into the cloud. But at the right price, we’d be comfortable owning it. VMW stock was also once a high-flyer, with P/Es over 100 as recently as 2010. The stock has fallen precipitously from a recent high in 2014 of $112 to $61 today. It’s still a highly volatile stock, but the valuation is much more reasonable now, at only 14 times adjusted EPS.
Finally, many of our customers own EMC stock in taxable accounts at a very low cost basis. We believe the most likely tax scenario is that all unrealized gains that EMC shareholders currently have will become realized gains upon completion of the merger. The IRS has not yet ruled on the proposed merger yet. If you hold stock in an IRA or other tax-deferred account, this does not affect you.
If the deal were worth another $3 or more per share, we’d be inclined to support it. If EMC shareholders vote it down, would Dell come back to the table with a higher bid? We believe they would, though it might be somewhat less than a $3 bump.
That said, more likely, the deal will be approved, and EMC shareholders would see around a $1 bump from current prices, depending on how VMW trades.
Charitable Givers Take Note
Therefore, if you have any charitable giving you’d like to undertake, and want to reduce your tax bill, you should consider using large-gain EMC shares that you own. The shareholder vote will take place on July 19, but you’ll have some time after the vote to make gifts.
If you have any questions about the deal, please don’t hesitate to email or call us.